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The paper provides a framework to help the weak retailer delineate the circumstances that allow him to benefit from an alliance between the dominant retailer and the common manufacturer. We use a game-theoretic model to determine the optimal pricing and service strategies when channel members act independently then when the dominant retailer forms an alliance with the manufacturer. We find that: (i) the alliance is formed only if the market is not strongly competitive in terms of price, (ii) differentiation in terms of price and service is beneficial to all channel members under alliance, (iii) an interaction between spillover and service effects plays a crucial role to make the weak retailer gain or lose from the alliance.

Today, dominant retailers (i.e., Wal-Mart, Home Depot, Lowe’s, Best Buy, Circuit City, etc.) are becoming more and more powerful in retailing industry. The channel coordination via strategic alliance between manufacturers and dominant retailers has significantly reshaped supply-chain management. The topic has recently gained big interest for academicians as well as professionals. There are several reasons for such interest. First, the dominant retailer is enjoying a large demand in the market (Epstein, 1994 and Wahl, 1992) and frequently is the largest distributor for the manufacturer. As an example, Wal-Mart is the world’s largest retail seller. The total market share of Home Depot and Lowe’s is more than 50% in home improvement (Knight, 2003). Second, the dominant retailer can run unique feature advertisements, information seminars and trade shows to promote the manufacturer’s products but the weak retailer is not able to implement such activities. As a result, the dominant retailer has made him-self very attractive for many manufacturers to engage in channel coordination via strategic alliance. We note that there is critical difference between “strategic alliance” and “vertical integration”. The former means that both parties try to reach common goals through a synergy of strengths (knowledge, expertise, reputation, financial resources, etc.) but remain independent. The latter means that two parties at two different levels of the distribution channel (for instance a manufacturer and a retailer) are under the same management and are controlled by the same company to increase its power in the market. Vertical integration is widely studied in previous marketing literature (e.g., Chiang et al., 2003; McGuire and Staelin, 1983) but strategic alliance was tackled by very few marketing papers (e.g., Yue et al., 2006). The main omission of the literature is the effect of strategic alliance on service strategy in the context of non-equal powered retailers. The importance of strategic alliance in the real business and the shortage of marketing studies about that topic have motivated us to explore the impact of strategic alliance on channel performance and channel’s members decisions. In this paper, we consider a supply chain made up of one manufacturer and two retailers. One retailer is dominant by enjoying a high primary demand and the other retailer is weak as his primary demand is lower than the dominant’s one. We extend the literature on strategic alliance by considering asymmetric retailers and studying, for the first time, pricing and service decisions simultaneously in that context. We determine the optimal pricing and service strategies under different market structures: (1) alliance between the manufacturer and the dominant retailer versus (2) no alliance. We use a game-theoretic approach to specifically study the following questions: • For each market structure (no-cooperation versus cooperative-strategic alliance), what should be the optimal pricing and service strategies that the manufacturer, the dominant retailer as well as the weak retailer should adopt? • Under which market structure can the manufacturer and the dominant retailer draw higher profit? • Is it always harmful for the weak retailer that the manufacturer and the dominant retailer form an alliance or are there circumstances that allow him to avoid such harm and also benefit from such cooperation? The rest of the paper is organized as follows. Section 2 provides a summary of the relevant literature. Section 3 presents the modeling framework and analyzes the cases of no-cooperation versus cooperative-strategic alliance. Section 4 presents our main results of the simulations and profit sharing. Conclusions and managerial implications are presented in the last Section 5.

Previous papers address service and pricing competition focusing on the context of equal-power retailers and using the wholesale price as a coordination mechanism. Other papers address channel coordination in the context of a single manufacturer and a single retailer. Another stream of research tackled strategic alliance from the financial, economic or management perspective with few contributions in marketing. The few papers dealing with strategic alliance and addressing marketing questions are centered on pricing decisions. Our paper addresses the value of strategic alliance in a manufacturer–multi retailers supply chain where retailers have different power and we use a game-theoretic approach to investigate the impact of such cooperation not only on pricing decisions but also on service strategies. We demonstrate that optimal pricing and service strategies exist under different market structures (alliance versus no-alliance) and we further obtain numerical results for different level of the model’s parameters. We summarize the managerial implications of our paper as follows. • By offering more service at lower price, the dominant retailer makes it impossible for the weak retailer to gain from the alliance unless the weak retailer offers more service at lower price as the case of Hanaro in Korea. Differentiation in terms of service and price is also a win–win situation for both retailers. To illustrate, Virgin America is highly differentiated company in terms of service offered which generate its success in the market against dominant airline companies like American Airlines. • Manufacturers will not accept to implement alliance with dominant retailers if the market environment is strongly competitive in terms of price. As an example, Apparel manufacturer VF, snack producer Nabisco and Delta Faucet preferred to form an alliance with weak retailers instead of dominant ones because of such environment. • The weak retailer is losing from the alliance if he competes strongly in terms of service with the dominant one and the spillover is not high enough. In other words, the weak retailer could not benefit from the service of the dominant retailer as the case of Metro PCS against AT&T. Trying to add more price competition does not allow the weak retailer to save his business from the power of the alliance. • Trying to increase price competition by offering low service level is even worse for the weak retailer to counter the strength of the alliance. As an example, Kmart experienced bad performance that pushed him close to bankruptcy in 2002 because of such mismanagement. • When the price competition increases between retailers, then either the retailer relies only on his service offer to attract consumers and benefit from the alliance or the direct-service, cross-service and spillover effects should all together be high so that the weak retailer could benefit from the alliance. The rationale is that the spillover effect alone is not sufficient to make the weak retailer gain from the alliance. A strong cross-service competition is also necessary to save the weak retailer from a substantial lost due to the strength of the dominant retailer. Various interesting extensions of this work are provided next. First, we assume that consumers have perfect information but future research should study the impact of incomplete information as well. Second, this paper is based on a single-period model. Therefore, it is a good idea to investigate how pricing and service strategies change in a multi-period game. Third, it will be more realistic to include the reputation of each retailer in the demand function instead of a fixed primary demand and let the reputation evolves over time. This will give more insights into the strategic impact of brand equity on the pricing and service level when the alliance is formed versus not. Finally, we find that the alliance could be harmful for the weak retailer. Future studies should propose some counterstrategies for him to survive in the market.